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ETF Clone of Morninstar's Stellar 401K -- Step 1 Map ETF's and Measure Returns

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In a previous article we reviewed Morningstar's 401K plan and said that it was a model plan that would be worth cloning with ETFs. Currently the Morningstar plan uses a range of funds that are managed and not ETFs.

Over the next series of articles we are going to attempt to build an ETF clone and learn, step by step, where we can improve performance to end up with an elegant and high performance plan.

The first step is to simply replicate each of the funds in each asset class with an ETF equivalent. We use the commission free ETFs selected by Morningstar for TD Ameritrade. Once we have done that, we will measure the performance of the portfolio against the original.

Below is the fund list for each plan so that you can see how it was cloned. For those that are interested, it is possible to substitute other ETFs.

Asset Class

401K

Clone

COMMODITIES BROAD BASKET

PCRIX

DBC

DIVERSIFIED EMERGING MKTS

NEWFX

EWX

DIVERSIFIED EMERGING MKTS

ODVYX

VWO

Financial

FSLBX

XVF

Foreign Large Blend

VWILX

VEA

Foreign Large Value

TBGVX

EFV

High Yield Bond

PHIYX

JNK

Inflation-Protected Bond

PRRIX

TIP

Intermediate-Term Bond

PTTRX

AGG

LARGE BLEND

SLASX

VTI

LARGE BLEND

VINIX

IWV

LARGE BLEND

OAKMX

VIG

LARGE GROWTH

HACAX

MGK

LARGE GROWTH

CISIX

VUG

LARGE VALUE

RWMFX

VTV

Mid-Cap Growth

BRWIX

IWP

Mid-Cap Growth

POAGX

VOT

MID-CAP VALUE

VASVX

VOE

Moderate Allocation

VGSTX

AOM

Multisector Bond

LSBDX

GVI

REAL ESTATE

REFDX

VNQ

Cash

CASH

CASH

SHORT GOVERNMENT

STABLEVALUE

SHY

Short-Term Bond

VBISX

BSV

SMALL BLEND

OTCFX

VB

SMALL VALUE

PSVIX

VBR


We were able to map each class from the TDA plan with the exception of:

Financial

FSLBX

XVF


We used XVF which is the ETF we use to monitor the US Sectors.

Asset Class

401K

Clone

Balanced Fund 1 1
REITs 1 1
Fixed Income 6 6
Commodity 1 1
Sector Fund 1 1
Foreign Equity 2 2
Emerging Market Equity 2 2
US Equity 11 11
Other 1 1
Total 26 26

We remarked that this was an excellent selection in terms of quality and balance.

We now compare the rankings.

Rating Attribute

401K

Clone

Diversification

97%

97%

Fund Quality

63%

33%

Portfolio Building

95%

49%

Overall Rating

86%

58%

We note that the diversification is the same but the fund quality of the managed funds are higher than the ETF index funds showing selections with good managers.

As a result, the ability to combine the funds to create strong portfolios is also reduced and so there is a significant difference between the plan ratings.

Once we have established a baseline, we will start working on improving the fund quality to see if we can get closer to the original.

At the moment, we are expecting the performance of the clone not to meet the the original.

Portfolio Performance

Performance chart (as of Jan 28, 2011)

Performance table (as of Jan 28, 2011)

Portfolio Name 1Yr AR 1Yr Sharpe 3Yr AR 3Yr Sharpe 5Yr AR 5Yr Sharpe
Morningstar 401K ETF Clone Tactical Asset Allocation Moderate 14% 96% 8% 62% 11% 71%
Morningstar 401K ETF Clone Strategic Asset Allocation Moderate 16% 139% 3% 14% 5% 28%
Morningstar Inc 401K Plan Tactical Asset Allocation Moderate 21% 157% 13% 122% 14% 122%
Morningstar Inc 401K Plan Strategic Asset Allocation Moderate 14% 165% 3% 22% 5% 32%


The returns are fair in an absolute sense even if we see this under-performing the original portfolio. We will expect to drive this up as we tune the fund selections.

We anticipate that with better fund selection, we will be able to drive up returns between 1-2% and we will see whether this turns out to be true.

When we use the TD Ameritrade plan with 101 commission free ETFs -- i.e. we give a wide choice for rotating funds, we are able to get much closer to the original plan.
 

Performance chart (as of Jan 28, 2011)

Performance table (as of Jan 28, 2011)


We have established an initial version of the clone with returns that are within striking distance of the original. We have shown that with a large selection of funds, we can meet the original in returns if not in elegance.

The next step is to start drilling down on individual ETF choices to see if we can drive the performance up.

Disclosure:

MyPlanIQ does not have any business relationship with the company or companies that provide the funds mentioned in this article. MyPlanIQ does not set up investment plans. The performance data of portfolios mentioned above are obtained through historical simulation and are hypothetical.



Disclosure: I am long DBC, DJP, IWO, IJR.
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